Canadian Competition Law Roles, Responsibilities and Relations in Emerging Electricity Markets

Mark Ronayne
Competition Bureau

Canadian Bar Association
Annual Fall Conference on Competition Law

September 20-21, 2001

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This paper was prepared for the Canadian Bar Association's Annual Fall Conference on Competition Law, September 20-21, 2001 in Ottawa. The author holds the position of Senior Competition Law Officer with the Civil Matters Branch of the Canadian Competition Bureau.

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The respective roles, responsibilities and relations of sectoral regulatory or oversight agencies and the Competition Bureau is an important matter for consideration in the restructuring of any network industry. In any of these industries, properly resolving this matter will be necessary to ensure that a level playing field for competition exists, that competitive market structures will be created or maintained and that market power and anti-competitive business practices will be effectively controlled with the minimum costs to businesses and the responsible agencies.

Establishing the appropriate roles, responsibilities and relations in electricity markets involves a unique set of challenges as compared to other network industries that have or are undergoing restructuring in Canada. This note provides a competition policy perspective on these challenges and outlines the Bureau's approach for dealing with them. Section 1 outlines relevant characteristics of electricity markets. Section 2 outlines key elements in the Bureau's approach. Section 3 provides some concluding remarks.

1. The Electricity Sector Context

Every electricity system contains the same five elements:

Traditionally, a vertically integrated, regulated monopoly provided all five elements. The tremendous economies of scale exhibited by transmission and distribution systems clearly make these natural monopolies. However, generation and customer services are at least potentially subject to competition. In a restructured electricity system both competitive and regulated elements co-exist following deregulation of competitive elements, re-regulation necessary to ensure electrical reliability, consumer protection and public values, and continued regulation of the remaining monopoly elements.

The pro-competitive restructuring of electricity systems involves a unique set of technological, competition and policy considerations with important implications for the appropriate roles, responsibilities and relations of sectoral regulators and oversight authorities as well as the Competition Bureau.

Technological Considerations

Electricity, as a source of power, is taken for granted by users. It requires only the wiring or plugging in and turning on of appliances or equipment. However, the development and management of an integrated electricity system capable of delivering power instantaneously on demand, within allowable tolerances and reliably to many thousands or millions of consumers is a highly complex undertaking.

Some of the technical and physical considerations that must be taken into account are as follows:¹

An important implication of these and other technical and physical characteristics of electricity systems is to place an especially strong emphasis on the need for strong central control. A system controller is an essential feature of any restructured electricity system.³ The controller must have control over electricity coming onto and being taken off the system on a minute to minute basis for system reliability reasons. The role of system controller is inherently a monopoly function, there can only be one for a system if it is to function reliably.

In a competitive market setting, the role of system controller has enormous financial as well as system reliability implications. The system controller ultimately determines which generators will or will not be dispatched on the electricity system, and which consumers will receive power. This must be done efficiently and fairly or competitive electricity markets will be incapable of providing efficient, low-cost and reliable power.

A second important implication of electricity system technology is the complexities it creates for, as well as high importance it places on, the design of competitive markets. An efficient competitive wholesale electricity market must be capable of properly ordering electricity supply to meet demand minute to minute, in real time 24 hours a day, 365 days of the year. The efficient order of supply must continuously take into account transmission system congestion and reliability constraints as well as the costs of different sources of generation. The design and management of markets capable of doing this is inherently complex, but, nevertheless, essential to obtaining the potential benefits from competition.⁴

Competition Considerations

One challenge in pro-competitive restructuring of the electricity industry, as with other network industries, is having to introduce competition in markets that have historically been dominated by vertically integrated monopolies. The complexity involved in doing this, however, is particularly great in electricity systems as are the requirements for subsequently detecting and mitigating the exercise of market power to obtain higher prices.

The complex nature of competition issues in electricity markets derives from the nature of electricity supply and demand as well as the requirements for operating a reliable electricity system. Depending on system conditions, such as peak demand in relation to supply, regional transmission constraints and generation or transmission outages, generators may have large amounts of market power for some hours or times of year.⁵

Moreover, detecting and preventing the exercise of market power in electricity markets is not an easy task. It may exist for only certain hours or days or during certain system conditions. It may also not be a simple matter to separate high prices that are caused by normal generation or system occurrences from high prices caused by the exercise of market power. For example, the withdrawal of generating capacity on a system resulting in high prices may reflect the exercise of market power or it may simply be the result of a legitimate shut-down for maintenance purposes due to failure. Determining the actual cause of the problem may not be a simple or straightforward matter.

A further complicating factor with respect to competition in electricity markets is the potential importance of market design for promoting competition. While market design is of secondary importance for promoting competition as compared to ensuring open access and that the number and types of competitors are sufficient, it can affect the number and types of competitors required as well as the potential for market participants to engage in anti-competitive practices such as bid-rigging and collusion. The creation of market designs that best promote competition while dealing with system reliability and technical constraints is inherently complex. No jurisdiction can be expected to fully resolve this matter before competition is introduced. Rather, ongoing monitoring and market design amendments are likely to be required to ensure that the most pro-competitive and efficient market designs evolve over time.

Policy Considerations

The nature of electricity systems and their development in Canada also creates a unique set of policy considerations as compared to other network industries. Unlike Canadian telecommunications and natural gas networks, electricity systems across the country have been developed along provincial lines. As a consequence, physical inter-connections and trade between provinces or between Canada and the US has traditionally been limited.

Accordingly, the potential for restructuring and issues to be dealt with vary from province to province. In considering pro-competitive restructuring, consideration must be given to each province's unique circumstances with respect to such matters as the size and nature of provincial demand and supply, the relevant transmission system characteristics and interconnections with other jurisdictions, provincial policy imperatives, the need to deal with stranded costs or benefits as markets are deregulated and the vertical structure of the provincial electricity system. While there may be common elements for restructuring, there is no single approach that can be applied across all provinces.

2. Getting Right roles and Responsibilities: Bureau Approach

The Bureau's approach to getting roles, responsibilities and relations right in regard to competition in emerging electricity markets reflects the above as well as traditional competition concerns regarding the pro-competitive restructuring of network industries. The approach is founded on the goals of maximizing the potential benefits from competition for consumers and businesses, ensuring effective control of market power and anti-competitive practices, promoting a more certain environment for investment and innovation in the emerging markets, and minimizing the costs of compliance with relevant provincial legislation as well as competition law.

Key elements in the Bureau's approach include the following.

i. Interventions in Support of Pro-competitive Industry Structures.

The first element in the Bureau's approach is to support the implementation of pro-competitive market structures as soon as possible. To this end, the Bureau has intervened and is continuing to intervene in electricity market structure reviews and hearings to promote pro-competitive restructuring. The Bureau has participated in numerous reviews and hearings dealing with electricity market restructuring starting in 1993 with the filing of a submission to the National Energy Board Review of Inter-Utility Co-Operation and Transmission Access and Wheeling. Over the ensuing period, the Bureau has provided submissions, commentary and analysis in reviews and hearings in four provinces: Ontario, Alberta, British Columbia, and, most recently, Nova Scotia. These interventions have covered issues ranging from creating an appropriate process for examining and implementing pro-competitive reforms to establishing appropriate terms and conditions for retail marketer codes of conduct.

Some of the market structure elements supported in these submissions include the following.

Competition with respect to generation or other electricity products and services should not be created for its own sake, but rather, as a means to promote the low cost and innovative supply of products and services meeting consumers tastes and needs. The potential for creating effectively competitive generation markets in any province will depend on the size and nature of supply and demand as well as interconnections and related arrangements with neighbouring systems. Clearly effective competition will be most easily established in large electricity systems, like Ontario's, with relatively strong interconnections to other systems. The feasibility of fully competitive markets may be less for smaller provincial electricity systems leading, in turn, to the need to introduce competition through an incremental process or in connection with other initiatives to allow greater inter-provincial or international trade and competition.

Creating effective generation competition in any electricity system will require careful analysis to determine the sizes and types of competitors needed. Once these needs are ascertained, divestiture of assets provides the most effective means to create competition as compared to other options such as leasing arrangements, power purchasing agreements, vesting contracts, or interim regulation.

The necessity of having a single system operator in any restructured electricity market was developed in the preceding section. Given the role of the system operator in determining which generators will or will not be dispatched on the electricity system, it is essential that it be structured to function independent of any market participant's interests.⁶

Also important will be ensuring that markets are created to support the efficient real time operation of electricity systems. At the core of the restructured electricity systems in Alberta and Ontario and most other jurisdictions is a central real time spot market. The market is used by the system controller to determine the least cost sources of power available on its system for balancing supply and demand at any time. It is also used by market participants to sell or obtain power to deal with imbalances between the amount of power they have available and the amount that is actually consumed by their customers. Restructured electricity systems may also include other central markets, for example, for the supply of system support services, for managing and pricing congestion, or for forward trades. For open and efficient electricity sector competition to take place, it is essential that these markets also be operated independently of any participant's interests.

The creation of retail competition, particularly at the household level, has proven to be more controversial in electricity restructuring in Canada and other jurisdictions than has been the creation of wholesale markets. The Bureau has supported the introduction of retail competition in previous interventions as a means to promote the development of innovative supply options to meet consumers' demands and promote more efficient price signals for consumers.

At the same time it is recognized that there are valid concerns to ensure that small consumers, in particular, are protected against excessive prices as markets are restructured. Consumers should, at a minimum, receive the benefits of wholesale competition through the pass-through of competitive wholesale or spot market prices. The pass through of these prices provides an appropriate yardstick for retailers to develop other supply offers that better meet consumers' tastes and needs with respect to such matters as price stability, term of supply and the potential bundling of electricity with other products or services.⁷

• Structurally separate utility competitive and non-competitive activities.

In any industry in which there are regulated essential facilities to which businesses need access in order to compete, the owners of the facilities will have incentives to provide preferential access to the facilities to their affiliates and to cross-subsidize their unregulated activities from their regulated activities.⁸ Guaranteeing the benefits from competition will require that careful attention be paid to ensuring that such preferential access and cross-subsidization does not occur. This is most easily achieved where there is structural separation between competitive and non-competitive businesses. Such separation should be established unless there is clear evidence that its economic costs would outweigh its competitive benefits.

In restructured electricity sectors, the need for structural separation is most evident with respect to transmission and distribution facilities, which are not only natural monopolies but are also essential facilities to which market participants need access in order to compete. Separation may also be required between monopoly and potentially competitive activities, that is activities that, although not yet competitive, may become competitive upon market opening. An example of a potentially competitive activity is electricity metering, particularly for households and small businesses.

ii. Support Effective Regulation of Transmission and Distribution Access and Pricing, Utility Affiliate Relations and Incumbent Market Power.

Structural separation between transmission and distributions systems and other essential facilities in restructuring electricity sectors will not by itself ensure all competitors of open and equal market access. In addition, the Bureau supports access and pricing of these facilities being subject to effective regulatory oversight.

Competition law is not as well-suited as industry specific regulation to deal with transmission and distribution access. Ensuring open and non-discriminatory access can involve the resolution of complex technical and pricing matters that an industry regulator is best placed to resolve in a timely manner. An industry regulator is, in any event, necessary to prevent the excessive pricing of essential facilities due to any market power residing in them.

Effective regulation will also be needed with respect to relations between transmission and distribution companies and their competitive market affiliates. This will be important to ensure that utilities are not able to provide favourable access to and cross-subsidize their competitive market affiliates. Also important will be regulatory oversight over the sharing of transmission and distribution information, such as the nature and timing of system expansions and consumer demand information.

Regulation is also essential to deal with the potential use of market power that incumbents may have at the time electricity markets are opened to increase or sustain prices in excess of competitive prices. It is not a contravention of competition law simply to use market power to increase or sustain high prices. Rather, regulation is needed to prevent incumbents that have market power at market opening from doing this. In addition to having powers to cap prices or impose other behavioural solutions in such cases, the Bureau has supported the regulator being given the authority to implement structural changes, such as divestitures, to create competitive conditions where warranted.⁹

To date, debate concerning the need for regulation to deal with incumbent market power as electricity sectors restructure has tended to focus on generation. As restructuring continues, however, it will be increasingly important to consider potential market power concerns at the retail market level, particularly for sales to households and small businesses. In these markets, affiliates of distribution companies may enjoy strong incumbent advantages through their historic association with distributors and possible roles as standard or regulated offer providers during the initial restructuring period.

iii. Support Establishment of a Market Surveillance Function.

In addition to effective regulation of the above matters, the Bureau has supported the establishment of a separate electricity market surveillance function. This position largely reflects the need for dedicated personnel to monitor and analyse the complex competition issues, as outlined in the preceding section, that may arise in electricity markets. Market surveillance can also assist in the detection of anti-competitive business practices particularly in markets run by the independent system or market operator.

A market surveillance function has become a standard feature of electricity restructuring in Canada, the US as well as other parts of the world.¹⁰ In addition to responsibilities in detecting market power and anti-competitive practices in markets run by independent market operators, they may have roles relating to the detection of rules infractions, analysis of market design, the collection, analysis and dissemination of market data and other matters.

iv. Promote Reliance on Competition Law to Deal with Competition Abuses Unless Regulation Clearly Better.

Open electricity markets carry with them the prospect of competition abuses under all substantive provisions of the Competition Act. Even in the early stages of restructuring, the Bureau has had a number of related cases under the bid-rigging provisions, as well as the merger and abuse of dominance provisions.

The Bureau believes that competition law should be relied on to prevent such anti-competitive business practices unless regulation is demonstrably better in this role. Competition law provides an effective set of disciplines for dealing with such practices where they create a significant threat to competitive markets. The law is an established part of the legal framework for businesses across Canada. It should be relied on unless regulation is clearly more effective taking into account the nature of the regulatory framework being put in place and the potential for dealing with the relevant business behaviour under the Competition Act.

v. Support Mechanisms for Removing Regulation When its Costs Outweigh its Benefits.

The Bureau believes that the regulation of market entry as well as price and other terms of sale for the purposes of preventing competition abuses or promoting economic efficiency should be avoided where the activity is subject to sufficient competition to protect the public interest.

Effective mechanisms should be put in place to ensure that regulation is removed when its costs outweigh its benefits. These mechanisms may include the use of either sunset or forbearance provisions.

Sunset provision have the benefit of providing a certain time frame for the removal of regulation. However, an appropriate time frame may not always be possible to determine beforehand. In such cases, the regulator, through the use of forbearance provisions, should itself be given a role in removing regulation.

To promote the timely removal of regulation, the Bureau supports forbearance provisions having the following basic elements:

To meet this test, it should not be necessary to establish that a market is approaching the perfect competition ideal. Rather, recognizing that regulation itself is costly and by nature restricts competitive behaviour, the Bureau believes that a market can be deemed subject to sufficient competition to protect the public interest if no firm operating in it has sufficient market power to unilaterally and profitably impose a significant and non-transitory price increase.¹¹ This is the basic test used by the Competition Bureau in determining whether or not to take action under the merger and abuse of dominance provisions of the Competition Act. The test has also been adopted by the CRTC in regard to the exercise of its regulatory forbearance powers under the Canadian Telecommunications Act. Canadian competition policy provides an established framework for determining whether sufficient competition does or would exist in regard to a product or service. This framework should be equally effective for determining electricity sector activities for which regulation is no longer needed.

The purpose of this requirement is to ensure both that competition law will be applicable in areas that are no longer subject to direct regulation, and to provide a clear signal that the primary role and responsibility for competition in the relevant market has devolved to the Competition Bureau. This is best achieved by the adoption, as was done in the Ontario Energy Board Act of 1998, of a separate regulatory forbearance provision clearly indicating that the Competition Act will apply where the regulator forbears.¹² Alternatively, where such provisions do not exist, regulators should clearly indicate the areas in which they are forbearing from regulation and their intention that competition law apply in these areas.

vi. Develop Interface Arrangements for Clarifying and Coordinating Roles and Responsibilities.

The final element in the Bureau's approach to roles, responsibilities and relations in electricity markets moving from regulation to competition, relates to managing the overlap that will inevitably exist in electricity restructuring between the Competition Bureau, market surveillance authorities and provincial sectoral regulators in dealing with potential anti-competitive practices. As an example of such overlap, in Ontario, the Market Surveillance Panel may investigate and report to the Ontario Energy Board on competition abuses taking place in markets operated by the Independent Electricity Market Operator. Following up on these reports or complaints received from interested parties, the Board may amend the relevant market participants' licences to prevent the competition abuses which may include anti-competitive practices.¹³ In Alberta, the Market Surveillance Administrator has broad powers and authority, including the ability to search and seize documents, to investigate potential competition abuses in Alberta electricity markets. Reports of the Market Surveillance Administrator are submitted to the Power Pool Council which oversees operation of the provincial electricity market. The Council, on further review has the authority to issues remedial orders as well as impose fines sufficient to deter the relevant behaviour.¹⁴

The Bureau's objectives in dealing with such overlap are to ensure that competition abuses are effectively controlled, that unnecessary or duplicative enforcement and compliance activity is kept to a minimum and that unnecessary costs for businesses to comply with both provincial legislation and the Competition Act are avoided. Toward this objective, the Bureau supports the development of interface arrangements between the relevant agencies to help clarify their respective roles and responsibilities to market participants and promote better inter-agency cooperation and coordination.¹⁵ These arrangements would not limit the respective agencies' legislative roles, responsibilities and authority. Rather, their purpose would be to clarify each organization's roles and responsibilities, help coordinate interventions in the relevant sector, minimize overlapping or duplicative investigations, and create a more certain competitive business environment.¹⁶

VI Concluding Remarks

To sum up this note, making the transition from regulated to restructured electricity markets is a difficult process for all involved. Regulators and market surveillance authorities are required to take on new and often unfamiliar roles and responsibilities in support of competition. Utilities and other businesses must adapt to a new competitive environment. The Competition Bureau must take on new responsibilities for ensuring that businesses comply with competition law in previously regulated markets.

In such cases, clarity regarding the roles and responsibilities of regulators, market surveillance authorities and the Competition Bureau is in everybody's interests, as is the effective coordination of these roles and responsibilities. The Competition Bureau is committed to working cooperatively with electricity sector regulators and market surveillance authorities to achieve these objectives.

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Footnotes

¹  A full description of the technical complexities of operating an integrated electricity system is beyond the scope of this note. For further discussion of this matter, see, for example, Paul Joskow and Richard Shmalensee, Markets for Power: An Analysis of Electrical Utility Deregulation, The MIT Press, Cambridge Massachusetts, 1985, chapter 4, William Hogan "Regional Transmission Organizations: Millennium Order on Designing Market Institutions for Electric Network Systems," Center for Business and Government, Harvard University, May 2000, and Adrienne Kwaczek and K. Morgan MacRae, Charting New Frontiers: Electric Power Reform, Canadian Energy Research Institute, Study No. 75, November 1996, chapter 6.

²  For example, if there are two transmission lines serving an area and one suffers an unexpected shut-down, increased power will automatically flow through the other. If the single line is insufficient to handle the increased power it will overload and also fail.

³  For a more detailed discussion of this matter, see William Hogan, "Electricity Market Restructuring: Reforms of Reforms," paper presented at the 20^th Annual Conference, Center for Research in Regulated Industries, Rutgers University, May 23-25, 2001, pp. 10-13.

⁴  For further discussion of market design and efficiency issues, see Robert Wilson, Efficiency Considerations in Designing Electricity Markets, Report prepared for the Competition Bureau, submitted to the Ontario Electricity Market Design Committee April 1998.

⁵  For further discussion of market power in electricity generation markets, see, for example, Michael J. Trebilcock and Michal S. Gal, "Market Power in Electricity Restructuring," World Competition Law and Economics Review, Vol. 22, No. 1, March 1999, pp. 119-169, and Lewis J. Perl, "Measuring Market Power in Electric Generation," Antitrust Law Journal, Vol. 64, No. 2.

⁶  In Ontario this goal has been pursued through the establishment of the Independent Electricity Market Operator. The Board of Directors for the Market Operator consists of independent members as well as stakeholder representatives. Decisions of the Board may be appealed to the Ontario Energy Board. In Alberta, system control and operation of the provincial power pool is within the responsibility of the Power Pool Council which consists of independent members.

⁷  For further discussion, see Submission of the Commissioner of Competition, Competition Act to the Ontario Energy Board Hearing on a Standard Supply Service Code for Electricity Distributors, August 3, 1999.

⁸  The strength of the incentive to cross-subsidize will depend on the type of regulation in place. Price cap regulation can help to deal with the incentive to cross-subsidize but does not eliminate the incentive to provide preferential access.

⁹  In comments on Bill 35, the Energy Competition Act, the Bureau supported the OEB being given powers to order divestitures by Ontario Power Generation (OPG) if needed to create competitive conditions in power generation in Ontario. At the time, OPG controlled over 90% of all generation capacity in the province. The Ontario government and Market Design Committee subsequently negotiated a Market Power Mitigation Agreement with OPG under which the company's share of all capacity for Ontario would decline over a number of years to 35%. However, whether the requirements placed on OPG by the Agreement will be sufficient to deal with market power concerns continues to be the subject of debate.

¹⁰  US Federal legislation actually requires that all authorized regional transmission operators operating interconnected competitive electricity systems have a market surveillance function with roles and capabilities set forth in federal legislation. For further discussion, see, for example, Gregory J. Werden, "Market Monitoring by Regional Transmission Organizations: What Role Should They Play in Detecting and Mitigating Market Power," the Electricity Journal, Vol. 13, No. 8, Oct. 2000, pp. 26-31.

¹¹  A lower level of competition may be sufficient in other circumstances if the costs of maintaining regulation would be greater than the benefits.

¹²  See Ontario Energy Board Act, section 29. Alberta electricity restructuring legislation also includes forbearance provisions, however, it is of more limited scope and does not require forbearance from regulation where there is sufficient competition. In this regard see the Alberta Electric Utilities Act, section 9.9.

¹³  For further discussion of the potential overlap between market surveillance, regulation and competition law in the emerging Ontario electricity markets in dealing with anti-competitive practices, see Competition Law and Policy in the Ontario Electricity Market Surveillance Landscape, Presentation to Synergy 2000 Conference by Mark Ronayne, Toronto, Ontario, June 14, 2000.

¹⁴  Alberta Market Surveillance Regulation, Alberta Regulation 278/98, section 15. It should be noted that Alberta legislation and regulation specifically allows the Council to refer matters and related information to the Competition Bureau if it involves activity that may contravene the Competition Act.

¹⁵  An example of this type of arrangement is the interface document developed between the Competition Bureau and the CRTC in November 1999, which is available on the Bureau's web site at http://www.competitionbureau.gc.ca.

¹⁶  Over the past several months, the Bureau has been involved in discussions with both the Ontario Energy Board and Independent Electricity Market Operator concerning the development of a joint statement between the three agencies.